IMC Asset Classes and Valuation

Question 1

A UK government gilt with a coupon of 4% and a face value of £100 is currently trading at £95. What is its current yield?

Accepted Answer

4.21%

Answer

Current yield = Annual Coupon / Current Market Price = £4 / £95 = 4.21%. The current yield is higher than the coupon rate because the bond is trading at a discount to its par value.

Question 2

Which of the following is a key characteristic of preference shares?

Accepted Answer

They receive dividends before ordinary shareholders and have priority in liquidation

Answer

Preference shares rank above ordinary shares for dividend payments and in the event of liquidation. They typically pay a fixed dividend and must receive their dividend before any payment is made to ordinary shareholders. However, dividends are not guaranteed — the board must still declare them.

Question 3

What is the intrinsic value of an in-the-money call option?

Accepted Answer

The amount by which the underlying asset's price exceeds the strike price

Answer

For a call option, intrinsic value equals the current price of the underlying asset minus the strike price (when positive). If the share trades at £120 and the strike is £100, the intrinsic value is £20. The option is in-the-money because exercising it would yield an immediate gain.

Question 4

Which valuation model estimates the value of a share by discounting expected future dividends?

Accepted Answer

The Dividend Discount Model (DDM)

Answer

The Dividend Discount Model values a share as the present value of all expected future dividend payments. The simplest form, the Gordon Growth Model, assumes dividends grow at a constant rate: P = D₁ / (r - g), where D₁ is next year's dividend, r is the required return, and g is the growth rate.

Question 5

A corporate bond is described as 'investment grade'. According to major credit rating agencies, which of the following ratings qualifies?

Accepted Answer

BBB-

Answer

Investment grade ratings range from AAA down to BBB- (S&P/Fitch) or Baa3 (Moody's). Anything below BBB-/Baa3 is classified as sub-investment grade or 'high yield'. BB+ is the highest sub-investment grade rating, while CCC and D indicate very high risk or default.

IMC Practice Test

IMC Practice Test

IMC Asset Classes and Valuation